Many of our clients are applying for a loan under the Paycheck Protection Program (PPP), a government initiative designed to provide a direct incentive for small businesses to keep their workers on the payroll in the wake of COVID-19. The loans are processed by private banks under the auspices of the U.S. Small Business Administration (SBA). These loans are to be forgiven, to the extent employees are in fact kept on the payroll for eight weeks and the money is used for permissible purposes, such as rent, mortgage interest, and/or utilities. Companies can apply through any existing SBA 7(a) lender or through any federally insured depository institution, federally insured credit union, and Farm Credit System institution that is participating. Lenders began processing loan applications on April 3, 2020. Though the SBA states that the PPP will be available through June 30, 2020, we are aware of companies being turned away from banks that are already overwhelmed.

Before a company applies, it should do a deep-dive into whether it is eligible for the loan in the first instance—because knowingly making a false statement to obtain the loan may be punishable by a fine of up to $1,000,000, or even imprisonment.  

Companies with fewer than 500 employees may qualify for the loan. Importantly, companies must include their affiliates’ employees in that count. “Affiliation” for this purpose is assessed by standards that are unique to programs overseen by the SBA. In this world, affiliation may take place under a number of circumstances, including affiliation based on (a) ownership (e.g., if an individual or entity owns or has the power to control more than 50% of the company’s voting equity); (b) management (e.g., when a board of director, officer, managing member, or partner of the company also controls the management of another company); or (c) stock options, convertible securities, and agreements to merge (companies must assume rights granted have been exercised when analyzing this type of affiliation), among others.

A common way affiliation can take place based on ownership, for SBA purposes, is when a minority shareholder has the ability, under the company’s charter, by-laws, or shareholders’ agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders. The rule of thumb is that control over matters necessary for investor protection (i.e., the ability of the shareholder to block certain extraordinary actions of the company) do not amount to control sufficient for affiliation purposes. However, when a shareholder has control over aspects of day-to-day operations of the company, that may constitute control sufficient to find “affiliation.” And affiliation means the company must start aggregating the employees of these affiliate-shareholders to see if the total exceeds the 500-employee limit under the PPP. Application of this rule is particularly complicated when the company is financed by venture capital, as many typical venture-style protective provisions are likely to suggest affiliation.  

To help understand how the SBA interprets its affiliation rules, below is a list of what provisions in a company’s governing or investor documents may, or may not, constitute control sufficient to make that shareholder an affiliate of the company—requiring the company to count that shareholder’s employees (and the employees of that shareholder’s “affiliates”).  

Provisions that may suggest affiliation

Provisions that likely do not suggest affiliation

Approving a director 

Approving new shareholders or withdrawal of old shareholders

Preventing a quorum or otherwise blocking an action by the board of directors or shareholders

Increasing or decreasing the size of the board of directors

Hiring and firing officers or executives

Increasing, decreasing, or reclassifying the authorized capital of the company

Setting compensation of officers or employees

Issuing additional stock or equity

Power over the corporate budget, incentive plan, or accounting methods

Amending the company’s organizational documents

Alienating or encumbering assets, so long as they are less than all or substantially all of the company’s assets

Selling, mortgaging, or encumbering all or substantially all of the company’s assets

Creating debt such as when borrowing money (even when that power is accompanied with a dollar limit)

Disposing of the company’s goodwill

Incurring expenses such as when purchasing equipment (even when that power is accompanied with a dollar limit) 

Power over any matter that could result in a change in amount or character of the company’s contributions to capital

Paying dividends (even when that power is accompanied with a dollar limit)

Approving the company’s new business venture that is substantially different than previous business(es)

Power over the strategic direction of the company (e.g., the establishment of new goals and new methods or plans for realizing those)

Committing to take any action that would make it impossible for the company to carry on its ordinary course of business

Power over non-competition provisions that limit the company’s ability to engage in certain businesses

Power over any act that would violate the company’s organizational document

Choosing an independent auditor

Initiating a lawsuit or arbitration, or entering into a confession of judgment

Amending or terminating current leases

Dissolving the company or filing for bankruptcy

In reviewing recent SBA appeal decisions, we developed this list over the past few days to assist us in advising clients, many of whom are not ready to give up on applying for a PPP loan if they can expeditiously and legally make changes to their governing documents to eliminate affiliation issues. (The National Venture Capital Association also has a similar list.)

As you would expect, our list is only a starting point. Each potential PPP applicant will need to analyze its own situation, and if the company has affiliation issues, or think it might, it should inform and work closely with counsel to assess the situation and, if appropriate, seek to amend relevant corporate governing documents.